21 Nov

The Battle of Business Models in Music

License Sales vs. Subscription

The battle of business models in internet music has the license sales model of Apple iTunes, Amazon and WalMart pitted against the subscription model of Spotify, Rhapsody and MOG. The two different business models represent very different ways of consuming music. Buying and owning a music title is different from being a member in a music club. We use the Simply Seven business model framework to highlight these differences.

If we were to place bets, we would say subscriptions will be the big winner in the end. This is because subscription services with their members-based approach to consuming music have the power to eat into illegal music consumption. We know that this is a very bold statement to make; indeed, digital music has been a graveyard for new ventures. SpiralFrog is just one of the many new businesses with brilliant founders that have failed in the digital music space.

The winner needs to be superior to illegal music consumption

A lot has been written in recent months about Apple vs the European streaming service Spotify. But the two contenders are not just racing against one another. There is a dark horse on the track, too: Illegal streaming and downloads. We all should all be less concerned about which of two paid models will win, but mainly about how successful the two legal models will be in persuading consumers to shift from illegal to paid music. This is a point that Will Page, Chief Economist of the UK licence collection authority PRS makes (link). He is joined by many others, such as Mark Dennis, head of digital sales at Sony in Sweden (link). It is all about beating the dark horse.

To make things even more complicated, next to the two legal horses and the dark horse, there is a grey horse, too. Grooveshark is hugely successful with its advertising based approach. But unlike Pandora and Last.fm, which are sticking to internet radio, Grooveshark offers individual track selection. It has an agreement with EMI but is being attacked by Universal, which means among other things having to live though the misfortunate experience of being pulled from Apple’s App Store (this happened in August 2010) because of Universal’s pressure.

And digital music is going to get even more unpredictable soon, if Google indeed launches its own music service – perhaps in Q1, 2011. This could be game changing, but it is too early to make any conjectures. Let’s get back to Apple and Spotify.

Using the Simply Seven framework

Our minds try to comprehend internet businesses in real world terms. This is one of the main points of Simply Seven. Buying digital music licenses over iTunes is like buying music in a store. We feel like we own the music we buy. If we own it, we want to be able to carry it around and play it everywhere. The key to success with this internet business model is building a seamless and easy-to-use ecosystem based on the idea of ownership consisting of a shop system, content management, players, devices and payment providers.While the sale of MP3s on Amazon and Wal-Mart is significant, the biggest player in this space by far is Apple. 70% of all digital tracks sold in the U.S. are downloaded from iTunes (link). And Apple has been the ecosystem wizard.

By providing devices, the shop as well as the proprietary music format, Apple is covering a lot of ground. Apple has sold over 275 million iPods. But even Apple cannot do it alone. Part of the attractiveness of the iTunes proposition is undoubtedly the vast array of other products out there that plug into this music universe, to sleek Bose players to the iPod connector jack in the BMW Mini. The New York Times counted 2,000 iPod add-ons in 2006, including a python-skin iPod case for $200 (Damon Darlin, “The iPod Ecosystem,” The New York Times, 03.02.2006) (link).

Two things that could slow Apple down

There are only two things that can slow Apple down. One is that Apple gets distracted. The major competitive war Apple needs to win now is with its iPhone mobile platform, which is being seriously challenged by Google Android on HTC and other devices. Android powered devices outsold Apple iPhone in Q2 2010. And Microsoft and RIM have not jet given up either. According to The Economist, the number of smart phone related lawsuits rises steadily by 20% per year (“The Great Patent Battle,” The Economist, October 23rd, 2010, page 69). This is probably what keeps Apple management awake at night, not the state of the music industry.

The second challenge for Apple is that people actually take up the subscription based business model for music. In Europe, this is happening. Spotify use so far is restricted to the UK, France and some other countries and iTunes sales are still going strong. But people who start to subscribe to Spotify may stop buying as many iTunes tracks as before. If this were true, it would be bad news for the music industry – they want to increase the pie, not decrease it. “We’re eating our young,” is what an NPD analyst, Russ Crupnick, told a music industry conference (link).

Why Spotify has the power to eat into illegal consumption

In Europe, Spotify is seen as the hero, not the villain. The Spotify team spent two years developing their software and creating a great player. Spotify made a massive bet by spending millions of their own, angel and venture capital money buying legal music licenses and giving them away to jump start free listening and conversion. Their business bet was that the free service would get so huge that a low percentage conversion rate for a premium subscription would eventually create a tipping point and the service would become profitable. Conversion rates indeed seem to be improving from a base of 5 to 6% (link). In Europe, a continent otherwise known for its smug complacency, people are cheering about a set of daring Swedes making huge business bets.

From a Simply Seven perspective, it is amazing Spotify, or for that matter anyone else, has gone for a subscription model. Subscription business models are extremely difficult to realise, because people generally don’t want to make binding commitments to pay in the future. People will only do this for two reasons: (1) Necessity – think electricity in your home – or (2) Exclusivity – think premium golf club full of business networking opportunities.It will be hard for Spotify to be a utility. There are other ways to acquire music online. If you manage to pull off offering a premium service, however, then you have it made. If you happen to be in a premium subscription segment, it actually makes sense to charge more to build up an aura of exclusivity. Of course, this is relative and depends on the wallet size of your target group. What seems premium to teenagers may not seem terribly expensive for a white-collar employee (do they still exist?).

Up price, don’t down price

What Spotify needs to do is make sure its premium service actually is premium. This is what golf clubs do. Premium subscriptions work in this way for diverse digital services like Bloomberg financial information or Blizzard’s World of Warcraft game. People subscribe to these services not because they are forced to, but because they feel like they are in a special club and provided with special access to something that excludes others. The members are an important differentiator for any club.

Music as a common experience

Indeed, Spotify is heavily investing in its social networking features like Facebook integration and a music “Inbox” which allows Spotify members to share music. Spotify CEO Daniel Ek was quoted saying (link):“If we can enable sharing of music on the internet, that application is going to be huge. That could be bigger than uploading your photos on the internet. Hundreds of millions of people want to share music with their friends . . . It would be as big if not bigger than what Facebook or Twitter is. Our ambition is to be one of those players that drives that.”

Apple considers the Spotify model a serious threat. From the iPhone, they know exactly how great it feels to own a premium service. Apple has responded by launching a social network focused on music called Ping, has invested in a large server farm in North Carolina and has bought Lala, a smaller streaming provider. In fact, there is a cutthroat war going on in the background surrounding Spotify’s planned launch in the U.S. with record labels not sure whether they should provide Spotify with U.S. licences and at what price (link). The music labels do not want to risk cannibalizing Apple’s sales and do not yet believe the story that Spotify will enlarge the market of legal music consumption.We think Spotify will be able to pull it off.  What Spotify changing the experience of music consumption from buying in a shop to being part of a club. In a way, this is a return to the future. Before music could be pressed into records and sold as a product, music was a shared experience. Common people would hear it in a church or create it together in choirs. This is what Spotify is returning to. If they are successful, Spotity will create an experience that may be superior to the experience of owning music, be it legal or illegal downloads.

If Spotify and the other subscription services can pull this off and be successful, it is not about beating Apple. It is about how music will be consumed in the future.